OCC readies new intraday margin requirement

The Options Clearing Corporation (OCC) is planning to implement new margin requirements in a third phase of an initiative aimed at safeguarding the options market from intraday risk.

The new margin calls will apply to all options positions in clearing member portfolios but will primarily affect zero-day to expiry options (0DTEs), derivatives contracts with less than 24 hours to expiry.

After a recent boom in activity, trading in zero-day options has grown to account for roughly half of all trading volume in S&P 500 index options and options on some index-linked ETFs.

In the first week of June, the OCC conveyed to member firms the draft details of phase three of its initiative during the clearing house’s Financial Risk Advisory Committee meeting, two clearing firms confirmed to Risk.net.

“For phase three they are going to issue intraday margin calls, and they have methodologies based on which they’re going to do that,” says one chief risk officer at a broker-dealer. “During the day, if they see a big peak, they’re going to call us for margin, and that has to be paid within one hour. But it’s all still in the works.”

“Intraday calls are in the draft phase,” confirms a chief strategist at a brokerage firm. “The OCC is recognising that as markets are getting more complex, they have to be more assiduous at recalculating margin and risk.” 

At the beginning of the year, the OCC introduced a new monthly add-on charge to pre-fund risk exposures from intraday trading from 0DTEs. In a second phase, in February and March, the clearing house applied the charge to all options positions.

The OCC is recognising that as markets are getting more complex, they have to be more assiduous at recalculating margin and risk

Chief strategist at a brokerage firm

That charge is based on expected daily “high peak” risk levels, calculated based on a clearing member’s daily peak exposures during the prior month. The methodology has been difficult for some clearing members to implement. 

A global chief risk officer at a third clearing firm describes the expected high peak approach as a “crude” means of monitoring intraday risk but likely the only achievable choice in the short run.

The exact details of the new intraday margin calls are still being determined. The OCC is currently proposing to call margin when a clearing firm’s intraday risk levels exceed three standard deviations above their historical average daily peak.

A clearing firm with an average daily peak risk exposure of $2 million with a standard deviation of $1 million would be called for immediate additional margin at risk levels of $5 million or more, for example.

“Let’s say one day, markets are really busy and my intraday goes to $6 million. They will call me for $1 million, which is due in an hour,” says the first CRO. Such a scenario would be rare, he says. “The problem is, these big peaks occur when the markets are busy. And that’s when you can get hit for a really large charge.”

The OCC hasn’t given a timeline for implementing its new measures, which Risk.net understands would first be published for public comment and require Securities and Exchange Commission approval.

Clearing firms will continue to pay the monthly add-on charge in addition to the new intraday margin. At the OCC’s Financial Risk Advisory Committee meeting, some members raised the issue of double counting, saying they would have to pay intraday margin on daily options positions and those same positions would also contribute to the firm’s monthly add-on charge.

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The OCC, meanwhile, is working to upgrade its capacity to calculate daily intraday margin at high volume.

“The frequency at which 0DTE margin will need to be calculated and monitored is far greater than other derivative instruments so it seems as though the OCC is looking to modernise as appropriate,” says an investment strategist at an options hedging and investment firm.

The OCC has reiterated to members that the intraday margin calls apply to all options positions, though, for many clearing firms zero-day options are the biggest contributor to intraday risk.

Analysts at JP Morgan said last year that trading in zero-day options could amplify volatility in US stocks, potentially transforming a 5% drop in the S&P 500 into a 25% plunge.

“One concern was that people were taking excessive unmargined intraday risk on the back of this product, and not all clearers, nor the OCC initially had full line of sight of that,” says the third clearing firm’s CRO.

The CRO says his firm researched how its clients trade 0DTEs and found that the professional side of the market was not taking excessive risk. “It’s not a particular entity or client set that seems to be going nuts on this. Or at least we couldn’t conclude that from the data,” he says.

But the second CRO reckons the market is changing, with some institutions increasingly using the options to speculate.

“I do think the best managed firms are on top of the intraday risk/reward that might be out there,” he says “But I can’t say that about every trading firm and every clearing firm. This is why the OCCs has had to tighten up the boundaries.”

The OCC declined to comment on its plans.

Editing by Rob Mannix